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Trade deficit blows out to above $2b

Australia's trade deficit yawned out to its widest in four-and-a-half years in October as imports rebounded while exports stayed flat, highlighting the pain a declining terms of trade is inflicting.

Today's figures from the Australian Bureau of Statistics showed the deficit on goods and services grew to $2.1 billion in October, from $1.4 billion the month before.

That was the 11th straight month of deficits and the largest shortfall since March 2008, another reminder of the hole that lower prices for key exports such as iron ore and coal have knocked in national income.

"At present the slowdown in the Chinese economy is depressing commodity prices and while volumes of coal and iron ore exports remain strong it is unlikely that trade surpluses will be back on the agenda till mid next year," said Savanth Sebastian, an economist at CommSec.

"Looking forward, the lower terms of trade will ensure the Reserve Bank can afford to boost household activity and as such further rate cuts cannot be ruled out."

The need to offset the drag from trade is a major reason the Reserve Bank of Australia (RBA) cut interest rates a quarter point this week to 3 per cent, matching the record lows set during the global financial crisis.

Indeed, investors suspect rates will have to fall further yet given the strength of the local currency and the Labor government's commitment to budget belt tightening.

Interbank futures imply rates around 2.5 per cent by mid-year while swap rates show a 54 per cent probability of an easing at the RBA's next policy meeting in February.

Australia's exports of goods and services edged up a bare 0.4 per cent in October at $24.4 billion, with a drop in coal earnings offsetting a bounce in iron ore and farm exports.

On the bright side, iron ore volumes picked up after a drop in September and exports to China were up 4 per cent on October last year and the highest in four months at $6.3 billion.

On the other side of the trade ledger, imports climbed 3 per cent to $26.5 billion, led by purchases of capital goods for major mining projects.

Prices for iron ore, Australia's single biggest export, have bounced to around $US118 a tonne from the deep lows under $US90 touched back in September, but remain well below the $US140-$US150 levels held early in the year. Prices for coal, the second largest earner, have been even weaker.

As a result the country's terms of trade, or the ratio of export to import prices, sank 4 per cent in the third quarter to be down almost 14 per cent on the year.

The drop in export earnings has in turn taken a heavy toll on company profits, and curbed investment plans, wages and tax receipts.

The damage was evident in figures for third-quarter gross domestic product (GDP) out earlier in the week. While real GDP growth was a respectable 3.1 per cent on the year, growth in current prices was just 1.9 per cent, far from the 8-per cent plus pace enjoyed at the peak of the trade boom.

Miners are still betting heavily that demand created by moving billions of people in China and India to urban centres will grow for decades to come, and are pouring massive amounts of money into mines and liquefied natural gas.

All this spending should eventually result in a significant increase in export volumes. LNG sales alone could be worth tens of billions of dollars to the country.

The catch is that much of this bonanza will not really start flowing until well into 2014, leaving the economy exposed in the meantime.